What is Capped Participating Preferred Stock?
Based on the prior examples from the guides of preference multiples and participating preferred stock, it may seem that these terms are unfair. That’s not exactly the case. Historically, most venture deals involved a non-participating preferred stock. In recent years, however, many investors have insisted on a participating preferred to avoid the situation wherein the company is acquired for approximately the post-financing valuation (i.e., there is no appreciation in the value of the company) and (1) the preferred shareholders receive their invested amount but no return, and (2) the common shareholders receive a substantial return based on their lower cost basis. In negotiating this point, the company would argue that the investors should not expect a return if the company does not appreciate in value and that the investors should not be paid on the front end (the initial preference payment) and the back end (the distribution of the remaining proceeds) if the company is successful.
